In our February legal updates we reported on an unsuccessful attempt by ASIC to remove the liquidators of two construction companies. ASIC claimed that the liquidators would be seen to lack independence, because of their links to the advisory firm who recommended them for the job. The judge did not agree, and the decision made some important points about a liquidator's duty of disclosure and impartiality.
ASIC appealed the decision, and on 18 July the Full Federal Court handed down a judgment requiring the removal of the liquidators – see the link below. The new decision is a very important one for liquidators, administrators, and anyone thinking of appointing them or challenging their appointment.
As we explain in our earlier article, insolvency practitioners (IPs) who take appointments as administrators or liquidators of a company must be able to assure creditors that they can do their job impartially and independently, uninfluenced by relationships with those involved in or associated with the company. Even the appearance that an IP might not be independent can be grounds to have them removed.
For this reason, upon accepting an appointment, the Corporations Act (the Act) requires an administrator or liquidator to disclose whether they have a relationship with the company or various people associated with it, and if so, why they believe they don't have a conflict of interest or duty in accepting the appointment. This is done in a document called a Declaration of Independence, Relevant Relationships and Indemnities (DIRRI).
The Full Court's judgment is likely to have a big impact on how liquidators and administrators deal with this duty of disclosure, and their duty to maintain independence.
Why was the appointment challenged?
Craig Walton was the director of two construction companies, together referred to here as Walton Construction. In mid-2013 Mr Walton engaged the services of the Mawson Group (MG), a business advisory and restructuring firm. MG organised asset sales from Walton Construction to various entities related to MG, leaving Walton Construction with up to $85 million in deficiencies of liabilities over assets.
MG then recommended that Walton Construction appoint administrators. MG arranged for Mr Walton to meet IPs from an accounting firm, Lawler Draper Dillon (LDD), to whom MG had referred a number of other such jobs. The meeting was held at the offices of MG, and was attended by one of MG's employees.
The IPs were appointed administrators of Walton Construction on 3 October 2013. They became the liquidators of both companies on 8 November 2013. It was clear that any liquidator of Walton Constructions would have to investigate the pre-appointment transactions with MG-related entities.
In December 2013 ASIC commenced legal proceedings, seeking a declaration that the liquidators had breached the Act by failing to make proper disclosure about their relationship with MG in their DIRRI. ASIC also sought to have the liquidators removed on the grounds that, because of this relationship, there might be a reasonable apprehension that they lacked independence and impartiality when winding up Walton Constructions.
These claims were initially rejected for reasons set out in our earlier article. The Full Court's decision in the appeal resulted in quite a different outcome which needs to be closely scrutinised by IPs and those who engage them.
The Outcome of the Appeal
The duty of disclosure
The good news for the IPs was that they were not found to have breached their disclosure obligations under the Act, which would have been an offence. When the IPs were appointed as administrators, they disclosed in their DIRRI that MG referred work to them from time to time. But ASIC argued that they should have gone further, and also informed creditors that it was likely that they would have to investigate the pre-administration transactions involving MG.
On this point, the Full Court agreed with the trial judge that the failure to mention the likely investigation was not, strictly speaking, a breach of their disclosure obligations. It found that the Act required the administrators to identify relationships, and reasons for believing there would be no conflict of interest or duty. The administrators had done this. The Act did not require that the DIRRI disclose possible future investigations.
The test for removal
However the Full Court found that the trial judge had applied the wrong test when she decided that the liquidators could stay in place.
ASIC was not alleging any actual bias on the part of the IPs; it was arguing that a "fair minded lay observer" might reasonably think that the liquidators might not be impartial and independent when investigating the pre-appointment transactions involving MG, given the closeness of the relationship between LDD and MG.
Because it was a matter of perception, the Full Court reviewed the various circumstances before and after the appointment of the administrators to determine what a "hypothetical fair-minded observer" might think about them.
When considering the Full Court's judgment it is important to note what did not give rise to a perception of bias. The existence of a referral relationship was not enough, by itself, to raise such a perception. Nor was the fact that MG had referred other appointments to LDD which also involved pre-appointment transfers of property from an insolvent company. Nor were the alleged failures of disclosure pointed to by ASIC.
Why the liquidators were removed
There were two matters that led the Full Court to decide that a fair minded observer might perceive a conflict of interests on the part of the liquidator, which could give rise to a perception of bias.
The first matter was the amount of the fees earned by LDD from MG referrals. During the two years of the relationship they were about $750,000, between 2% and 4.4% of LDD's total revenue. The Full Court found that the fair minded observer would not think this to be insignificant, and might think that the liquidators would be influenced in discharging their duties, consciously or not, by a desire to protect this revenue stream.
The second matter was the fact that MG, who would be investigated in the liquidation, influenced the choice of the appointment of the liquidators who would investigate them. The Full Court commented that although it was not unusual for advisers to recommend IPs, in this case it was like a litigant being able to choose their own judge. Although there was no suggestion of any actual misconduct or lack of diligence by the liquidators, the fair-minded observer might well think that MG regarded LDD as being more likely than others to look after its interests.
Questions had been raised about LDD's impartiality at creditor's meetings for Walton Constructions in October and November 2013. The Court took this to be confirmation that a hypothetical fair minded observer would share the same concerns.
So the Full Court decided that the liquidators would have to be removed, notwithstanding the substantial disruption and cost this would involve.
Although ASIC's complaints about the DIRRI were dismissed, this was because both the trial judge and the Full Court adopted a strict reading of the relevant provisions of the Act. IPs should still carefully consider this decision, and review how referral relationships are described in their DIRRI.
However, when insolvency practitioners grapple with the implications of this case, we would suggest that they think about independence and impartiality generally rather than referral relationships in particular. The Full Court specifically recognised that IPs are in business and that referral relationships are part of that business.
When insolvency practitioners are assessing their independence for a job, whether from a referral relationship or otherwise, the test isn't whether they think they are independent. And the test isn't whether they in fact will do a good job and comply with their legal and ethical obligations.
What matters is this – how would an appointment be seen by a fair minded, appropriately informed lay person? There are many circumstances, including but not limited to referral relationships, that will be relevant when answering this crucial question.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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